Will the euro ‘speak’ German or European?

Theo Waigel, Germany's finance minister at the time when the European currency was about to be launched, had no doubt about the euro's Germanic lineage. At a bitter-sweet commemoration of the German mark's 50th anniversary – and its impending demise – in 1998 he proclaimed to his doubtful compatriots that "Der Euro spricht deutsch" (the euro speaks German).

That's what it took to convince Germans to part with their trusted and beloved mark, and to relegate their revered monetary authority (Bundesbank) to the regional office of the European Central Bank (ECB). But Waigel and his boss, the former Chancellor Helmut Kohl, took no chances. Doubting that they would have the votes to win a referendum, they pushed the introduction of the euro without consulting public opinion.

Today, the German Chancellor Angela Merkel would have no such problem. In the last elections on September 22 of this year, only a tiny and marginalized party (Alternative for Germany), with 4.7 percent of the popular vote, wanted the country out of the monetary union.

In spite of the financial crisis, Germans apparently believe Ms. Merkel when she tells them that "the euro is good for us." And it is. Last year, the depressed euro area still took 40 percent of German exports and accounted for the same share of German trade surpluses. Thanks to the euro, Germany can comfortably finance its public debt at an interest rate of 1.74 percent, and record-low costs for consumer and mortgage loans resonate nicely with the German public. Only the good old Bundesbank keeps railing against too much of a good thing.

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That bounty is in sharp contrast with high unemployment and rising poverty in France, Italy, Spain, Portugal and Greece, whose recessions were allegedly aggravated by Germany's dilatory crisis management and a harsh punishment with devastating austerity policies.

Germany ignoring trade adjustment obligations

With its large trade surpluses and perceived as playing up its "safe haven" appeal to attract capital fleeing the rest of the euro zone, Germany was not only seen by many observers as being insensitive toward its closest trade partners, but was also accused of violating the rules of international trade adjustment.

What are these rules? They are simple, robust, symmetrical and routinely followed in IMF and OECD policy consultations with their member countries. Here is what they say: countries running external surpluses, low budget deficits (or balanced public sector accounts) and low inflation have to stimulate domestic demand, while countries with trade deficits, budget gaps and high inflation have to cut back on domestic spending.

According to these rules, Germany had been consistently living off its trading partners while dressing that up as the self-proclaimed "virtue" of wise and prudent economic management. Over the last eight years, for example, here are Germany's average annual readings for macroeconomic indicators pointing to the need of trade adjustment: (a) current account surpluses of 6.6 percent of GDP, (b) budget deficits of 1.2 percent of GDP and (c) consumer price inflation of 1.8 percent.

Clearly, all these years Germany had the obligation to bring down its large trade surpluses by spending more so that its main trading partners could sell it more and avoid quasi structural trade imbalances on their German trades. In fact, an appropriate trade adjustment (for both surplus and deficit countries) is a must in a monetary union to prevent instabilities which inevitably lead to major financial crises.

US Treasury doing the euro area job

But the euro area countries – and the EU Commission – failed to implement the economic policy coordination that could have prevented the huge waste and suffering they will experience for years to come.

It took a sharp criticism of the U.S. Treasury late last month to raise heckles in Berlin. [This network carried an even sharper criticism of German beggar-thy-neighbor export-led economic policies a little more than a year ago in the op-ed piece "Germany Can Lead Euro Zone Out of Recession."]

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Here is the Treasury's mirabile dictu: "Germany's anemic pace of domestic demand growth and dependence on exports have hampered rebalancing at a time when many other euro area countries have been under severe pressure to curb demand and compress imports in order to promote adjustment …"

What was the German government's response? "Incomprehensible," they said, about the Treasury's plain English and mainstream economic views. And with an angry swipe at Washington that it "should analyze its own economic situation," Berlin's finance ministry smugly brushed it all off saying that Germany's surplus was "a sign of the competitiveness of the German economy and global demand for quality products from Germany."

That is like saying "let's change the conversation." The fact remains that a large trade surplus is an indication of weak domestic demand, and that a systematic surplus in excess of 6 percent of GDP is a refusal to stimulate internal spending. In view of that, one can understand that Germany would rather not talk about this, because it is an unsuitable topic for a country whose trade surpluses accounted for 70 percent of economic growth in the last two years.

But the Treasury and Germany's long-suffering euro partners have two important allies.

The first one is the ECB, whose deft monetary policy may be beginning to make some headway. Euro area loans for house purchases – the most important segment of bank lending to households – increased 0.8 percent in the year to September, marking a slight acceleration from 0.7 percent in the previous month.

A lot of that mortgage lending is apparently taking place in Germany. Rents and house prices in the country's seven largest urban areas are 20 percent above the average – a flare-up Bundesbank attributes to low mortgage costs.

This is an excellent development because when people buy a house they also buy furniture, appliances, maybe even a new car. Germany's third quarter numbers for gross domestic product are showing some of that since consumer spending and construction sectors made a strong contribution to economic growth.

The other Treasury's ally is, improbably, Germany's Social Democrat Party (SPD) – the coalition partner in the next government with the right-wing Christian Democrats (CDU/CSU). Among the key SPD demands are pro-growth euro area economic policies, a more cooperative attitude toward euro area partners and a minimum hourly wage of 8.5 euros.

There are other things on its agenda, too. Trying to forestall the much feared sweep of radical right-wing parties (riding high on public discontent with unemployment and rising poverty) in next May's European parliamentary elections, the SPD seems determined to accelerate the monetary union's economic recovery. With an eye on 2017 elections, the SPD also wants to increase its political clout by binding together Germany's entire center-left political spectrum, and by actively cooperating with similar parties in France, Italy and other euro area countries.

This promises to usher in a period of hopefully friendly political tensions in Germany's next grand coalition government. And if, as the rumor has it, Germany's new finance minister were to be a convinced SPD Europhile, we may finally have the euro that truly speaks European.

Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia.

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